Page 125 - Bankruptcy Volume 1

fresh-start reporting. However, plans that allow the debtor to regain control at the end of five years only
if selected operating profit targets are satisfied will not preclude the use of fresh-start reporting because,
in such instances, the existence of the targets may support the conclusion that the change is substantive
and not temporary.

Situations in which a stockholder is also a creditor present some unique issues. If a stockholder receives
a controlling interest in the reorganized corporation as a result of receiving stock not for prior stockhold-
ings, but instead as a distribution on an allowed claim the stockholder may hold, should fresh-start re-
porting apply? For example, assume that Stockholder A, who owns 10% of the debtor’s stock, is a sup-
plier to the debtor and holds the largest claim. If this creditor receives 70% of the equity in consideration
of its claim and 1% as a result of the equity interest, it would appear that the requirements of fresh-start
reporting are met.

Shares issued to creditors with respect to an allowed claim or to holders of existing voting shares imme-
diately before confirmation as a result of a new value contribution should not be considered as shares is-
sued for this purpose, even though such creditors or investors may have held voting shares of the debtor
prior to emergence.

When calculating the percentage of voting shares a preconfirmation equity holder retains, only shares is-
sued on account of the holdings of preconfirmation voting shares should be considered. Any shares is-
sued on account of a preconfirmation equity holder’s additional role as a creditor or contributor of new
value should be considered as shares issued to a new holder.

The Chapter 11 process, although allowing the debtor to initially have the exclusive right to propose a
plan of reorganization, is designed to protect the rights of creditors and recognizes the creditors’ superi-
ority over existing equity. Accordingly, despite a debtor-in-possession’s exclusive right to file a plan of
reorganization, the debtor-in-possession must negotiate with the creditor body to confirm a plan. This
negotiation process provides the basis for considering new voting shares issued on account of an exist-
ing equity holder’s additional standing as a creditor or as a contributor of new value as a factor in estab-
lishing a change in control.

In situations where new voting shares are issued on account of an existing equity holder’s additional
standing as a creditor or as a contributor of new value, the voting shares issued by the reorganized entity
must be reasonably proportional to the allowed claims or new value when compared to distributions of
voting shares made to other creditors. If the distribution is found not to be reasonably proportional, there
is a presumption that the amount of shares issued that are not in proportion are issued on account of pre-
existing holdings of voting shares. These shares should be considered as issued to a pre-existing share-
holder in applying the requirements for purposes of FASB ASC 852-10-45-19.

The task force that developed the predecessor to FASB ASC 852, AICPA Statement of Position 90–7, in
describing comments received from practitioners, noted in paragraph 61 that some concluded that "the
combination of change in majority ownership and voting control — that is, loss of control by the exist-
ing shareholders, a court-approved reorganization, and a reliable measure of the entity’s fair value — re-
sults in a fresh start. . . ." Others justify the use of fresh-start reporting on the basis that "a change in con-
trol and the exchange of debt and equity based on reorganization value is in substance an acquisition at
fair value by new shareholder. . . ." The task force concluded that, under either view, a new reporting en-
tity is created and assets and liabilities should be recorded at fair value. Based on these comments, and
the loss of control by the old shareholders in the example — in which the creditor-shareholder owning
only 10% of the equity prior to the reorganization receives a 70% ownership of the new company as a
result of debt — the conditions for fresh-start reporting are satisfied.

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